Legal Briefing

Finance | 01 June 2014

For a long time the issue of rent payable by a corporate tenant in administration appeared to be settled1. Landlords were apparently content to accept that, when a tenant company went into administration, the rent owing under the lease at the date of the administration was an ordinary unsecured claim. For the period of the administrators’ occupation and use of the premises they would pay the rent reserved by the lease apportioned on a daily basis as an expense in the administration. This established approach to rent in administration has come to be known as the ‘flexible’ or ‘pay as you go’ approach and was given judicial approval in the early 1990s in the leading case ofRe Atlantic Computers Systems Plc (No 2)[1990].

The very difficult economy post the Lehman crisis hit landlords hard, particularly in the retail sector, and the move by landlords to challenge the settled position on rent in administration probably stems from the frustration of those difficult years. Whatever their motivation, landlords challenged the established way of doing things in two cases,Goldacre (Offices) Ltd v Nortel Networks UK Ltd[2009] andLeisure (Norwich) II Ltd v Luminar Lava Ignite Ltd[2012]. Both cases were first instance decisions in the High Court which abandoned the established ‘pay as you go’ principle and the result was to leave the issue of rent in administration in ‘a very unsatisfactory state’2, that, of course, created difficulties for both landlords and administrators of tenant companies.

Last July (2013) another case on the question of rent in administration came before the High Court:Re Game Station Ltd (Jervis v Pillar Denton Ltd & ors)[2013]. The judge at first instance simply followed the decisions in theGoldacreandLuminarcases without hearing sustained argument and gave leave to the landlords to appeal to the Court of Appeal.

GAME STATION: THE QUESTIONS BEFORE THE COURT OF APPEAL

The main issue before the Court of Appeal in theGame Stationcase was the treatment of rent payable under a lease held by a corporate tenant that goes into administration. Specifically, when is rent an ordinary provable debt (entitling the creditor only to be paid pro rata along with other ordinary creditors) and when does it rank as an expense of the administration (meaning that it is paid in priority to the unsecured creditors)? For landlords, the answer to these questions was the difference to being paid in full promptly or sharing in a (usually) small dividend paid to ordinary creditors months or years after the event. The issue is also crucial for administrators in planning the successful achievement of the objective of the administration: the rescue of the business or some part of it as a going concern in accordance with s3(1) of Schedule B1 of the Insolvency Act 1986.

GOLDACREANDLUMINAR

Lewison LJ reviewed the first instance decisions in bothGoldacreandLuminar. InGoldacre, the first instance judge decided that if a quarter’s rent (payable in advance) fell due during a period in which administrators were retaining the property for the purposes of the administration, the whole of the quarter’s rent was payable as an administration expense. This applied even if the administrators were to give up occupation later in the same quarter. InLuminar, the judge decided that where a quarter’s rent payable in advance fell due before entry into administration none of the quarter’s rent was payable as an administration expense, even if the administrators retained possession of the property for the purposes of the administration. The judge held that the rent was to be treated simply as a provable debt in the administration.

The commercial result of these decisions was that it became almost standard practice for companies to go into administration immediately after (or shortly after) a quarter day, thus avoiding liability to pay the rent in full for the quarter, even if they retained possession of the leasehold property throughout the quarter. For landlords, the position was made worse where there was a swift sale of the business, because the result was sometimes that the purchaser would also benefit from the rent free period for the rest of the quarter.

THE FACTS INGAME STATION

Game Stores Group and other group companies were tenants of several hundred retail stores held on lease. In all of the relevant leases rent was payable quarterly in advance on the usual quarter days. On the 25 March 2012 quarter day, approximately £10m became due under the various leases. The rent was not paid. The group companies went into administration the day after the quarter day. Some of the stores were closed down almost immediately. Trading continued in other stores, which were included in a swift sale of the business and assets of the group to the purchaser Game Retail Ltd (which had taken the name of the group but was not part of it). At the time of the appeal in February 2014 (nearly two years later) £3m of the March 2012 rent remained outstanding in respect of stores which were purchased by Game Retail.

The administrators took a neutral stance and the appeal was driven by the landlords who were aggrieved that the purchaser, Game Retail, should have a three-month rent-free period under the leases they acquired from the group in administration. The judgment does not explain this situation, but presumably it arose because the purchaser was in occupation of the numerous premises under licences from the Game group companies in administration and therefore the landlords were prevented from taking action to forfeit the lease by the administration moratorium protecting the Game group companies.

COMMON GROUND BETWEEN THE PARTIES

The common ground between the parties was as follows.

At common law rent is not apportionable in respect of time; rent payable in advance is not apportionable under the Apportionment Act 1870.

Whether rent was payable as an administration expense is not a question of an exercise of the court’s discretion. Rent either counts as an expense or it does not; if rent falls within the principle known as ‘the salvage principle’ (also known as ‘the liquidation expenses principle’ or ‘TheLundy Graniteprinciple’), then, it is an administration expense.

The court should apply the salvage principle in the same way in an administration as applied in liquidation, because of the similarity of the respective rules. These are set out in the Insolvency Rules 1986 – Rule 4.128 applies to liquidation and Rule 2.67 applies to administration. For example, Rule 2.67(1)(a) refers to ‘Expenses properly incurred by the administrator in performing his functions…’ and R2.67(1)(f) refers to ‘any necessary disbursements by the administrator…’

THE SALVAGE PRINCIPLE

In the Court of Appeal, the only reasoned judgment was given by Lewison LJ, who reviewed the relevant case law in some detail in order to explain the application of the salvage principle to rent payable by an insolvent tenant. Lewison LJ explained that the 19th century cases were confirmed in the 20th century particularly by Lord Hoffmann in theRe Toshoku Finance Ltd[2002]. Lewison LJ said that the salvage principle was formulated in a 19th Century Court of Appeal case calledRe Lundy Granite Co exp Heavan(1870-71) in which James LJ said:

‘In some cases between the landlord and the company, if the company for its own purposes and with a view to the realisation of the property to better advantage remains in possession of the estate, which the lessor is therefore not able to obtain possession of, common sense and ordinary justice require the court to see that the landlord receives the full value of the property’.

‘Where the liquidator retains the premises for the purposes of [the winding up] the rent of it ought to be regarded as a debt contracted for the purpose of the winding up of the company and ought to be paid in full like any other debt or expense properly incurred by the liquidator…’

These cases were recently explained further and confirmed by Lord Hoffmann, in the House of Lords inToshoku, who said:

‘Lindley LJ was saying that it would be just and equitable in the circumstances…to treat the rent as if it were an expense of the winding up’.

THE ‘FLEXIBLE APPROACH’

The flexible approach, or, as it has come to be known the ‘pay as you go’ approach was the approach the courts used to adopt in these situations. The Court of Appeal referred to the decision inRe Atlantic Computers, in which Ferris J in the High Court ordered sums due under equipment leases, where the equipment was retained for the purposes of the administration, were to be paid as administration expenses and treated as accruing on a day-to-day basis.

Lewison LJ decided that the salvage principle applies to rent payable in administration. He referred to the judgment inLundy Granite, observing that the principle is not expressed in terms of when rent falls due. He noted that, in fact, it is framed by reference to the period during which the company uses the landlord’s property to its advantage. Lewison LJ said:

‘I cannot see why common sense or ordinary justice should be defeated by the happenstance that a rent day occurs immediately before the date of the entry into administration if the rent fallen due on that day covers a period during which the administrators obtain possession of the property for the benefit of the administration. As Ferris J said inRe Atlantic Computer Systems Plc (No 2)all that is necessary is to treat the rent as accruing from day to day’.

THE COURT OF APPEAL’S COMMENTS ON GOLDACRE

Lewison LJ said the key question was the extent to which rent is payable as a result of applying the salvage principle. The administrators argued that the payments should be tailored to the use of the premises by them. The first instance judge rejected that and held that rent payable in advance was not apportionable under the Apportionment Act 1870. This led the judge to conclude that the quarter’s rent was payable in full as a cost and expense of the administration and could not be apportioned even if the administrators were to vacate the premises during the quarter.

The Court of Appeal disagreed with the first instance judge’s decision inGoldacre, indicating that the fact that the rent was not apportionable under the Apportionment Act would not necessarily rule out application of the salvage principle. The Court pointed out that the judge’s decision was inconsistent with another case calledRe HH Realisations Ltd[1975], a decision of Templeman J which was expressly approved in theToshokucase. The basis of theGoldacredecision was also wrong in that it was partly based on ‘the adoption principle’ as referred to in the House of Lords’ decision inPowdrill v Watson[1995], which was on a different point and in which the salvage principle was only referred to by way of analogy. The Court decided that the adoption principle does not apply to periodical payments such as rent.

THE COURT OF APPEAL’S COMMENTS ON THELUMINARCASE

Luminarwas a case concerning companies operating nightclubs held under leases and the rent was paid quarterly in advance. In October 2011 the companies went into administration. The main issue concerned the rent due on the September quarter day. The judge in theLuminarcase decided that where rent is payable in advance and falls due for payment prior to commencement of the insolvency proceedings, then it is provable but not payable as an expense in the administration even though the administrators retain the property for the purposes of the administration. However, where rent payable in advance becomes due during the period when the administrators were retaining the property for the purposes of the administration, then the whole sum is payable as an administration expense even if the administrators vacate before the expiry of the rent period.

The Court of Appeal pointed out the flaw in the judge’s decision inLuminarin not appreciating that Lord Hoffmann’s decision inToshokumeant the right to prove a pre-liquidation debt and the salvage principle were not mutually exclusive. The Court pointed out that inToshokuLord Hoffmann did not distinguish between debts accruing before the liquidation and debts accruing afterwards. Both are therefore capable of falling within the salvage principle. The Court of Appeal therefore did not agree with the first instance judge’s interpretation ofToshoku. The Court also noted that the judge inGoldacrewas not shown the decision inAtlantic Computer Systems Plcand that the case was referred to in skeleton arguments before theLuminarjudge but was not considered in his judgment.

GAME STATION: SUMMARY OF THE COURT OF APPEAL’S DECISION

In summary, the Court of Appeal held as follows: the true extent of the salvage principle is that the administrators must pay the rent under the lease as an expense of the administration for the period during which they retain the leasehold property for the benefit of the administration; the rent will be treated as accruing from day to day.

The duration of the period is a question of fact and it is not to be determined by reference to which rent days occur before, during or after that period. This is in line with the underlying principle formulated inLundy Granite. The Court commented that theLuminarjudge lost sight of the fact that the salvage principle is founded in equity and not on the common law. However common law would view an instalment of rent payable in advance is not determinative of how equity would treat it. The right approach is encapsulated inRe Atlantic Computer Systems Plcand the earlier case ofShackell v Chorlton & Sons[1895], in which the judge had adopted a ‘wait and see approach’. The Court therefore overruledLuminar. It also overruled theGoldacrecase, commenting that the judge was wrong to apply the ‘adoption principle’.

RENT IN ADMINISTRATION

The Court has indicated clearly that the ‘pay as you go’ approach – although Lewison LJ did not call it that – is the correct approach to be adopted in administration. This is probably the best outcome for both landlords and tenants in administration: certainly the position is now much clearer. The Court confirmed that the same approach will also to apply to the use of premises by liquidators. However, there are still some outstanding issues, as follows:

The Court did not deal with the situation where the administrators retain part only of a leasehold property. The question of rent in relation to part of the premises not occupied remains outstanding. The question there is to what extent the administrator is entitled to pay rent pro rata based on the area of the leasehold premises that is being retained for the benefit of the administration, instead of the full amount of the rent due under the lease. This was an issue inGoldacre. The flexible approach, as put forward inAtlantic Computer Systems, suggests that administrators might be able to argue the point successfully and it would be in keeping with the rescue culture. However, the point remains open.

The case does not really consider the issue of what is beneficial user for the benefit of the administration. InGame Stationthe administrators’ agents spent five days clearing stock from the premises and it seems to have been accepted that that was not user of the premises but a clear intention to abandon the lease.

The Court of Appeal does not give guidance as to where rent as an expense in the administration stands in the hierarchy of administration expenses as set out in Rule 2.67 of the Insolvency Rules – in which rent is not referred to specifically, of course. However, sensible administrators will assume that payment of rent is to be made before payment of their own remuneration.

Game Stationgives no guidance on the liability of the tenant company in administration for dilapidations. That seems to be a step too far, unless the administrators’ use of the premises has caused specific damage to the premises. However, the question remains open.

RETROSPECTIVE CLAIMS BY LANDLORDS

Can landlords have retrospective claims for rent they missed out on? The overturning of theGoldacreandLuminarcases suggests that there might be cases out there, in which theGoldacre/Luminarapproach was used, resulting in the landlords having to forego rent for the best part of a quarter. Landlords might wish to look into those situations, to see whether they might have claims now for rent unpaid by administrators. However, making a retrospective claim based on a change in case law is never straight forward and so landlords should consult their legal advisors before taking any action.

Notes

See the author’s article in the May 2013 issue ofThe In-House Lawyer: ‘Rent in administration; a headache for landlords’.